Position: Short France (EWQ)
As we spelled out in our Q2 Theme call, the Sovereign Debt Dichotomy will not be isolated to Greece. While the fiscal excesses of the Greek government were first to be exposed, we’ve called for Spain, France, and Italy to follow, with the spotlight reaching the USA in 6-9 months.
Following spending and austerity measures issued in recent days by Spain, Portugal, and the UK, Italian PM Silvio Berlusconi announced a $30 billion plan in spending cuts late yesterday and is vocal today calling the measures “absolutely necessary” to defend the Euro and Italy, saying “defending the euro today means saving Italy’s future.”
Like Greece, Berlusconi’s government has plenty of fat to trim in the form of bloated civil service pay over recent years and room to rein in tax evasion (Italy’s annual tax revenues lost are 2nd only to Greece). While the package is a start, we don’t think the package alone (nor Berlusconi’s confidence) will be enough to deflect the reality of Italy’s fiscal problems. While Italy’s budget deficit of 5.3% of GDP is nearly half of those ‘affectionately’ named the PIIGS or Club Med countries, Italy’s total debt as a percent of GDP is as large as Greece’s at 115%.
Clearly, Berlusconi has seen the repercussions of the media’s frenzy with Greece (the Athex Index is down 28% YTD), and doesn’t want Italy to be next. Don’t forget that Berlusconi also has his own interest in the performance of the country’s capital markets as one of Italy’s wealthiest businessmen.
One initial signal we’re following for heightened fears is CDS price. The chart below shows a recent spike in Italy’s 5YR CDS. While far from a 940bps high in Greek CDS in early May, or the 300bps tipping point for Lehman Brothers and Bear Stearns, this rise could be an early indication of something much bigger: the reality that you cannot kick the can of debt down the road in perpetuity.